There are two key difficulties, both of which have been discussed extensively in the past few years. The first is that the Central Statistical Office (CSO) uses single deflation (deflating the nominal value added in each sector by various price indices) rather than the internationally standard technique of double deflation (deflating output by output prices and inputs by input prices). The failure to use double deflation matters hugely when international prices of critical inputs such as oil move sharply, as they have in recent years because of the pandemic and then Russia’s invasion of Ukraine.
The second issue is that a number of sectors of the economy are deflated by inappropriate indices. In particular, the wholesale price index (WPI) for manufacturing is used to deflate the nominal magnitudes for several non-traded services sectors that account for an important share of total gross value added.
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Let’s avoid the gory entrails and instead subject the GDP deflator to a smell test. Figure 2 shows that the GDP deflator peaked at 11.6 per cent in the first half of FY23, then collapsed to just 0.2 per cent in the first quarter of FY24. Does this really correspond to our sense of inflation trends in the economy? Has inflation really been eliminated in recent months?
Certainly, the CPI shows no such thing. Headline CPI-based inflation peaked at 7.2 per cent in the first half of FY23, then eased modestly to 4.6 per cent in the first quarter of FY24. Core inflation, which strips out volatile food and fuel prices, is even more stable, averaging about 6 per cent throughout the period.
What are your thoughts on this ?
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